VIENNA/June 18 – When OPEC extended the production cut deal for all of 2018 at the November 2017 meeting, Russia insisted on adding language to the communiqué that required a review of the market needs for the production caps at the mid-year OPEC meeting. Now Russia is getting its money’s worth from that move last year as it makes clear its view that the caps are no longer needed while pushing OPEC to increase production.
On May 25, Russia proposed an increase of 1 million barrels per day (b/d) at the St. Petersburg economic summit. Publicly Saudi Arabia seemed open to the idea in order to keep Russia in the oil market coordination game but privately say they favor a much smaller increase.
The Saudi’s don’t believe there is a production problem but are trying to address various political problems: Trump tweets, calls from energy ministers in consumer countries seeking relief from high prices, and preserving the oil market alliance with Russia. So Saudi Minister Khalid al-Falih stated last week that an increase is “inevitable” but it will be “moderate and reasonable” and nothing “outlandish”.
But Russian Energy Minister Alexander Novak is not tamping down expectations. Russia is reported to be proposing a 1.5 million b/d increase for the third quarter 2018 only. In reality, this would translate into a 750,000 b/d increase for the second half of 2018 if you spread out over Q3 and Q4.
OPEC sometimes favors these mixed messages that provide something for everyone. It would give the Russia the ability to say it was 1.5 million b/d increase but allow others to say it was only 750,000 b/d.
Still, we think --- whether 1. 5 m b/d for one quarter or 750,000 b/d for the remainder of the year --- it would seem to have a difficult chance getting support from OPEC as a whole which requires unanimous consent.
We believe a 750,000 b/d increase is still too high for the other OPEC members. Most ministries we consulted last week said they didn't see need for any increase and want to avoid taking any action that results in a price decline. But the lower the number the greater the chance there will be support for increasing production, as all OPEC members realize it is important to address Russia’s concerns to keep them in the fold on market coordination.
We continue to believe any added production will be in the 300,000 to 500,000 b/d range as we said right after the St. Petersburg push for 1 million b/d that caused oil prices to sharply decline. But market expectations of 1 million b/d in added production are too high for what OPEC can deliver. As a result, we think OPEC action this week will provide bullish momentum for prices.
There is a great deal of press attention now to comments by the Iran oil minister who said they will veto any effort to increase production along with Iraq and Venezuela. The Iranian minister said OPEC should not “appease Trump” and his call for more production. Normally Iran and Russia would be aligned but Trump has now managed to drive a wedge between that relationship.
OPEC’s rules require unanimous consent to change policy so theoretically Iran could veto the push for more production.
Saudi Arabia realizes other OPEC members are not keen on any increase but are making the case that the group needs to address concerns of consumer countries as well as fellow partner Russia. They are also circulating proposals for a lower production increase that Russia is seeking to try and achieve consensus.
The Saudis and Russia are also prepared to tell the rest of OPEC that if they don't agree, Saudi/Russia will just increase production unilaterally if more stick than carrot is needed to get agreement.
Our friend and former OPEC President Chakib Khelil told us last week that unilateral action is rare and so he expects there to be consensus on a lower number.
But if there is no official OPEC agreement, we will expect to see Saudi Arabia and Russia signal in public comments that they will ease compliance for a certain time period and increase production to a “moderate and reasonable” level. Again, we think this will be in the 300,000 to 500,000 b/d range. While doing so, they will stress that the production cut deal is still in effect and added production increase will not breach the overall 32.5 million b/d cap. It is worth noting here that the ministers from Saudi Arabia and Russia co-chair the OPEC compliance committee.
As an aside, we think the Saudis are teaching a master class on managing competing political objectives. They are responding to Russia/Trump calls for more production but at a level that won’t lower prices with the looming Aramco IPO around the corner. At the same time, they have set up Iran to look like the bad guy if they veto any OPEC increase and prices go higher. Look for a new Trump tweet soon focusing on Iran’s blame for higher prices.
